Flawed Buffett Rule Reintroduced in Senate

3 min readBy: Kyle Pomerleau

This week, Senator Elizabeth Warren (D-MA) reintroduced the Buffett Rule under the name the “Fair Share TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. .” This tax would be used to pay for a program that allows students to refinance their higher education loans at lower interest rates.

Generally, the “Fair Share Tax,” or Buffett Rule is a 30 percent minimum tax (income tax plus payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. minus charitable deductions) on individuals who make $1,000,000 or more.

High Income Individuals Already Pay High Effective Tax Rates and Pay a Disproportionately Large Share of the Income Tax that the Federal Government Collects

The whole idea of the “Fair Share Tax” is based on the belief the high income individuals are not paying enough in taxes, or are paying lower effective tax rates than those who earn less. Warren Buffett famously claimed that his employees paid rates that average 36 percent while he only paid an effective tax rate of 17 percent.

Anecdotes aside, this is not how the U.S. tax system works. Our progressive taxA progressive tax is one where the average tax burden increases with income. High-income families pay a disproportionate share of the tax burden, while low- and middle-income taxpayers shoulder a relatively small tax burden. system taxes people at higher rates as they earn more. A recent Joint Committee on Taxation (JCT) study showed that those who make $1,000,000 or more pay an effective tax rate of 27 percent on just their federal individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. . Although not an effective tax rate of 30 percent, it is still higher than any other income group.

Even if you were to include the effect of payroll and excise taxes, which hit low income taxpayers harder than high income taxpayers, the distribution is still very progressive.
High income taxpayers not only pay the highest effective federal tax rates, they pay a disproportionately large share of the income taxes that the federal government collects. According to the most recent IRS data, the top 1 percent paid 35 percent of all income taxes in in 2011. This is more than the bottom 90 percent paid combined.
The Buffett Rule is Poorly Structured
Besides the 30 percent effective tax rate in the Buffett rule, there is a phase-in of the tax over $1,000,000 of AGI. This phase-in creates a spike in taxpayer’s marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. of over 50 percent. Our current tax code is no stranger to hidden marginal tax rates caused by phase-ins and phase-outs. However, these are not positive aspects of the code. They obscure peoples’ true tax burden, add unnecessary complexity, and create marginal tax rate cliffs that incentivize people to change behavior to avoid them.
A good tax code would try to minimize these distortions while raising sufficient tax revenue.
Other Revenue Raisers Could have been Used
Perhaps it is desirable to raise more revenue or tax high income individuals more in order to pay for this student loan refinance program. If that is so, there are better ways of doing it than using the flawed Buffett Rule.
The United States already has an Alternative Minimum Tax (AMT), which went into force in 1970 in order to deal with this exact issue. Rather than creating a third parallel tax system with another set of deductions, rates, and rules, Congress could fix the existing AMT.
Alternatively, Congress could raise the existing tax rates to pay for this program. At least this way, the higher tax burden would be transparent to Americans.
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